Tuesday, January 17, 2017
9:52:24 PM EDT

Storm Ahead

by
Jim Brown

Normal storms do not bother the equity market but this storm could cause serious damage.

Market Statistics

The storm the market is afraid of is a Tweet Storm from the president elect. Several times over the last week, the tweets have caused significant fluctuations in equities. Some were good and some were bad. It appears Trump is trying commit suicide by tweet with some of the recent notes attacking his own party. If Trump is to be successful as president he needs to turn his Twitter account over to a rational and political savvy third person who could then change the password on the account to prevent those late night Twitter fights.

With worries growing on which of Trump's policy promises will actually come true the market is losing confidence and he has yet to actually be sworn in as president. Numerous policy divisions have appeared between Trump and his cabinet and now he is attacking the republican tax proposals. Analysts are starting to say the corporate tax cuts to 15% will never pass but maybe 20% or even 25% could be the eventual rate. While 25% is a lot lower than we have today it is far from the 15% rate Trump promised. Stocks with high tax rates that have rallied since the election, are starting to fade as the expected tax windfall shrinks.

The first 100 days could be a series of battles between Trump, congress and the Republican Party. Trump's tweets have been lightning bolts from the blue for many companies as his comments roil expectations. Last week retailers like PVH and Nike crashed after comments about raising import taxes. Today PVH spiked more than 6% and twice the Friday decline on Trump comments that the republican proposal, which would have taxed all imports, was "too complicated." Trump wants to charge a punitive tax on imports from companies that have left the U.S. but ship products back into the country. He tweeted over the weekend he wants to put a 35% tariff on German cars.

Some people claim this is the way Trump negotiates. He throws out an obscene number then negotiates to a lower rate. The problem with this strategy as president is that he is putting it out through tweets that rock the equities in that sector and that moves the markets. A private businessman can use that public strategy but a president needs to be more aware of the market impact and the impact of expectations around the world.

Several analysts have said that Trump's tweets could increase in quantity and severity this week before he is actually sworn into office. They claim he is trying to develop some momentum for his positions so he can hit the ground running next week. If he does not learn the art of subtlety very soon he may be running into a brick wall in the weeks ahead. While I commend his efforts, he could be his own worst enemy and that could produce some rocky markets after the inauguration.

Historically, the market is not kind to a president in the first 30 days after the inauguration. In the table below, which covers the last 11 presidents, the S&P-500 declined an average of -2.59% in the first 30 days of a presidency. This does not take into account any pre inauguration market gains and losses. Given our recent post election gains, it would suggest any decline could be intensified if it appears Trump's promises/policies are not going to be immediately implemented. There is a lot of risk that many of them will be blunted severely and/or face a tough uphill battle. That suggests future tweet storms against anything that stands in his way. Picking a twitter fight with Boeing over Air Force One is a lot different than picking a fight with China's President Xi over islands in the South China Sea, currency manipulation or tariffs on Chinese imports. There could be significant ramifications from Twitter wars with other foreign leaders.

Trump said over the weekend he might leave the inauguration day festivities early so he can get a head start on making changes. We are entering a new and uncharted world in presidential politics and that could be unsettling for the market.

Data from SPGMarketIntel

The only material economic report on Tuesday was the NY Empire State Manufacturing Survey for January. The headline declined from 9.0 to 6.5. However, the 9.0 from December was also revised lower to 7.6 so it was a double dose of bad news. December was still the highest level since April. Unfortunately, new orders declined from 10.4 to 3.1 but all other components improved. The backorder component rose from -10.4 to -1.7 and employment improved from -12.2 to -1.7 as well. Inventories improved from -13.9 to +2.5.

On the negative side the prices paid component rose from 22.6 to 36.1 indicating inflation is accelerating. That component was 15.5 in November. Manufacturers are passing on some of the price hikes with the prices received component rising from 3.5 to 17.6. With inflation accelerating it could limit expansion plans and reduce employment growth expectations.

The calendar for Wednesday has the Fed Beige Book as the most important report followed by the Housing Market Index and Consumer Price Index. If we start to see consumer prices rising as fast as the NY manufacturing report above, it could kick the Fed into high gear on their rate hike plan. That would obviously be market negative.

The Philly Fed Survey on Thursday is the next most important report but it will probably be ignored in the build up to the inauguration on Friday.

The Q4 earnings cycle was the focus of attention this morning as another group of companies confessed and issued guidance. Morgan Stanley (MS) posted earnings of 81 cents that beat estimates for 65 cents. Bond trading revenue more than doubled to $1.47 billion. Equity trading revenue rose 7.3% to $1.95 billion. Forecasts were for $1.0 billion and $1.84 billion respectively. Total revenue rose 17% to $9.02 billion, which also beat estimates for $8.48 billion. Shares fell -4% with the entire financial sector declining 2% on worries Trump's deregulation would not occur in the near future and tax rates would not decline as much as promised.

Dow component UnitedHealth (UNH) reported earnings of $2.11 compared to estimates for $2.07. Revenue of $47.5 billion beat estimates for $46.8 billion. Revenues from the UnitedHealthcare segment rose 15.5% to $38.9 billion. The Optum segment saw revenues rise 1.4% to $22.2 billion with a 23.7% rise for the full year to $83.6 billion. Total members rose from 46.4 million to 48.59 million. The company affirmed its guidance for 2017 for revenue of $197-$199 billion and earnings of $9.30-$9.60 per share on an adjusted basis. Shares gapped down from $162 to $157 at the open but rebounded to close at $160.62.

After the bell, CSX Corp (CSX) reported earnings of 49 cents and analysts expected 50 cents. Revenue rose 9% to $3.04 billion thanks to an extra week in the quarter. Overall volume declined -1% to 1.63 million units and coal volumes rose 3%. Dollar revenue from coal rose 16%. Automobile shipments were strong but commodity shipments continued to be weak. The company said headwinds from low commodity prices were impacting the number of shipments and that would continue. They are also suffering from the strong dollar which is impacting exports and it will take another six months for the impact to be fully felt by CSX. Shares fell $1.50 in afterhours to $36.50.

United Airlines (UAL) reported earnings of $1.78 compared to estimates for $1.73. Revenue of $9.05 billion matched estimates. Revenue per seat mile declined -1.6%. For the full year, United repurchased $2.6 billion in stock and has $1.8 billion left on the current authorization. They forecast Q1 revenues to be flat and analysts were expecting 41 cents and $8.28 billion. Shares declined $1 in afterhours.

Gigamon (GIMO) warned after the close that earnings would be in the 35-37 cent range compared to guidance for 36-38 cents. Revenue of $84.5-$85.0 million would be well below guidance of $91-$93 million. Shares fell -22% in afterhours. They said several major customers had deferred purchase decisions until 2017.

Walmart (WMT) tried to get on the good side of Trump by announcing it was going to add 10,000 new retail jobs as it opens new stores. The new construction would employ 24,000 workers over the next two years. The store plans had been previously announced but the announcement touting the new jobs was clearly an effort to stay out of the future Trump tweet storm. Amazon did the same thing last week when it said it was adding 100,000 workers over the next 18 months. The Walmart announcement did halt a two-week slide in the stock price.

GM announced a planned investment of $1 billion in U.S. factories and the addition of more than 1,000 jobs. GM has been under fire from Trump for manufacturing cars in Mexico. Shares were flat on the day.

Tiffany (TIF) said comparable same store sales declined -4% during the holiday shopping period. They blamed this in part to a 14% decline in sales at the Fifth Avenue store in New York because of traffic disruptions around Trump Tower after the election. The company said they do not anticipate a significant improvement in economic conditions in 2017.

JC Penny's (JCP) agreed to allow Nike (NKE) to open Nike Outlets in 600 of Penny's stores. The store within a store will occupy 500 sqft in the men's department and will feature "pumped up visual elements." They will feature an expanded assortment of performance and "athleisure" apparel and accessories. Nike shares gained slightly on the news.

Disney (DIS) was upgraded from neutral to buy at Goldman Sachs. The bank said the film offerings for 2018 were going to be the best slate ever. They also have a new park on the horizon and they will benefit from a lower tax rate and the ability to repatriate cash from overseas. Shares were flat for the day.

Reynolds American (RAI) finally agreed to a deal to be acquired by British American Tobacco for $29.44 per share plus half a BAT share. That was $2 billion over an initial offer made in October. Shares gained 3%.

Clayton Williams Energy (CWEI) agreed to be acquired by Noble Energy (NBL) for $3.2 billion. This greatly expands Noble's acreage positions in the Delaware Basin portion of the Permian. This provides Noble with 120,000 net acres and 4,200 drilling locations with more than 2 billion Boe of net unrisked resource according to Noble. The cash and stock deal was valued at $138.97 per CWEI share as of Friday's close. Shares spiked to $145 because Noble shares gained $2.66 on the announcement.

Markets

The major indexes were really mixed today with the Dow and S&P down only 0.29% while the Russell 2000 fell -1.43%. The small cap S&P-600 fell -1.36% and the Russell Microcap index was down -1.8% so the weakness was definitely in the smaller stocks. The big caps continue to be a storehouse of cash for fund managers but they are bailing from the low liquidity positions. The Russell 2000 closed at a five-week low.

Despite the weakness in the small caps, the rest of the market was choppy. The big cap indexes gapped down at the open on events in Europe and Asia but there was no panic. The indexes trades sideways most of the day with another dip at 2:PM to the lows for the day. Dip buyers were ready but the volume was weak as though conviction was fading.

The S&P did not close far from its highs and no harm was done. This was just a consolidation day for the big cap indexes. The S&P is not showing any weakness and without a drop below 2,250 the movements are just noise.

The Dow declined to 19,775 intraday and the bottom of its recent range. The 19,800 level is the psychological bottom but the intraday declines have penetrated that level several times since mid December only to rebound by day's end.

Goldman and JP Morgan were the biggest losers as the financial sector lost -2%. JP Morgan was downgraded by KBW from outperform to market perform. Shares fell -$3 on the downgrade to knock more than 20 points off the Dow.

Goldman's $8.56 loss knocked 56 points off the Dow. Goldman was due for a major bout of profit taking and this could be the start.

Note that the support on Goldman mimics the support on the Dow.

The Nasdaq dip was just a hiccup after a string of gains. The Nasdaq is now up 8 of the last 10 days so it is hard to say the selling was material. The big cap tech stocks were all on the wrong side of the winner/sinner graphic today. The biotech sector was also negative with a -2.31% decline on Trump fears. Despite the big caps and the biotechs declining the Nasdaq barely even stumbled.

The Dow transports have given up some of their gains from November thanks to worries about cross border taxes and the impact of the strong dollar. They are still holding the majority of their gains but the 9,000 level is in danger.

The rest of this week could be rocky but the rebound today suggests the dip buyers are still alive and well. Whether they will continue to buy the dips right up until the start of the inauguration process is unknown. There is event risk but there is almost no sign of that risk in the market. The VIX gained only 0.64 to 11.87 today despite the down market. Given the risk and the market weakness, we should have seen a more significant spike. Investors remain complacent as though Trump was going to touch the bleachers on Capitol Hill and turn them into gold.

When investors are the most complacent is when the biggest declines normally appear. Let's hope this is not one of those times.